Weekly global economic update

What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.

Ira Kalish

United States

The economic impact of climate change worsens

  • Similar to the summer of 2022, record-breaking temperatures have been reported from all around the world lately. Indeed, the world recently saw the hottest week since records began 174 years ago. In the United Kingdom, June was the hottest month on record. In late June, temperatures in Spain hit 44 degrees Celsius. In Italy, a dozen cities are under heat alert. In Greece, the Parthenon is closed due to heat. In Europe overall, temperatures have risen faster than the global average since the 1980s. And in recent days, the US Southwest has also experienced record-breaking temperatures. Phoenix has had roughly three weeks of temperatures above 110 degrees Fahrenheit (43 degrees Celsius)—a record. This rise in temperature globally has been widely attributed to climate change, which exacerbates heatwaves due to the greenhouse gas effect of burning carbon-based fuels. In addition, climate change has been responsible for recent unusually heavy rains in India and China. 

There are several problems with persistent unusually high temperatures. They boost demand for electricity; disrupt power grids, sometimes requiring power outages; disrupt agricultural production, clean energy production (hydro and nuclear), and inland transportation; spark wildfires; reduce water levels; and probably hurt human productivity. 

As for electricity, the current heat wave is already disruptive. For example, in May, Chinese hydroelectric generation was 19.2% lower than a year earlier. Yet record temperatures mean higher-than-usual power demand. In Vietnam, it is reported that the government is cutting back on public lighting. In addition, it has obtained agreement from 11,000 enterprises to reduce power consumption, including foreign invested companies from China and South Korea. And, in Germany, the water level at a crucial point on the Rhine River is now at the lowest level in 30 years.

On the other hand, a major shift toward cleaner energy is under way. In Europe, more electricity is now generated by wind and solar than natural gas. Yet there remains a substantial volume of carbon-based fuels being emitted into the atmosphere. Until the world approaches carbon neutrality, the impact of carbon on the climate will likely continue to be onerous and may worsen further. Thus, climate change (not climate mitigation) is having a disruptive impact on the global economy that is not likely to abate. This suggests that governments and businesses will increasingly have to take climate risk into account while planning for the future, regardless of the impact of climate policy. Numerous industries are expected to be affected, including agriculture and food processing, transportation, power generation, insurance, and other financial services.  

Russian action disrupts global food market

  • When the war in Ukraine began in 2022, shipments of grain from Russia and Ukraine were disrupted by military action in the Black Sea. Prices of grain soared, threatening the food security of many emerging nations that depend on grain from Russia and Ukraine. Then, a deal between Russia and Ukraine, known as the Black Sea Grain Initiative, was brokered by Turkey that allowed grain shipments to continue unimpeded by military threat. That deal expired this week and Russia chose not to renew it. 

Now, it is reported that Russia’s military is bombarding Ukrainian ports and threatening Ukraine-bound vessels in an effort to disrupt Ukraine’s ability to ship grain to the rest of the world (although Russia’s ambassador to the United States said his country has no plans to attack civilian ships). In the past year, Ukraine shipped 33 million tons of grain. If that is disrupted, Ukraine will lose valuable revenue and the world will lose access to grain. Indeed, the price of wheat has soared this week in response to Russia’s decisions. 

Meanwhile, Ukraine said that, in response, it will treat Russian vessels as military targets. A Ukraine spokesman said that vessels headed toward Russian ports in the Black Sea can be considered to be carrying military cargo and are subject to “all the relevant risks.” Russia is the world’s largest wheat exporter with expected exports this year of 47 million tons. About 70% of Russian wheat exports go through Black Sea ports. Thus, Ukraine’s threat can potentially have significant effects on Russian revenue, global wheat prices, and food security in emerging nations such as Egypt or Pakistan. Also, much Russian oil moves through Black Sea ports, accounting for about 1% of global oil consumption. Oil prices have not yet reacted to this information. 

It is also reported that NATO is concerned about the situation. A spokesman for NATO said that “we treat the Black Sea, half of which is bounded by NATO countries, as though it is Russian-occupied territory, like eastern Ukraine.” He said that Ukrainian ships can avert Russian attack by hugging the coastlines of Romania, Bulgaria, and Turkey, all of which are NATO members. A senior EU official said that “if this grain is not only stopped but destroyed, this is going to create a huge food crisis in the world.” He concluded that Russia’s actions will likely lead to more European military aid to Ukraine. Also, the EU is looking to newly re-elected Turkish President Erdogan to play a role in easing the crisis, especially given his relatively good relations with Russian President Putin. In fact, there has lately been increased talk about renewing negotiations for Turkish entry into the EU. 

Finally, it is reported that grain buyers in Asia are already seeking alternative sources of wheat given the latest events in the Black Sea. Of particular interest is Australian wheat. The major buyers of Ukrainian grain in the region are Indonesia, Malaysia, Vietnam, South Korea, Thailand, and the Philippines. The wheat is used not only for human consumption but also as animal feed. A shortage could thus influence the price of meat.

China’s economy continues to grow slowly

  • When China removed COVID-19–related restrictions at the end of 2022, there was an expectation that the economy would roar back. Indeed, it grew relatively rapidly in the first quarter, with real GDP rising 2.2% from the previous quarter. That had been the second-fastest growth since early in the pandemic. However, since the first quarter, China’s economy has been sputtering. Last week we learned that real GDP increased only 0.8% from the first to the second quarter and was up 6.3% from a year earlier. Keep in mind that, a year earlier, there was a sharp decline in real GDP. Thus, the 6.3% growth was buttressed by the base effect of a weak year-ago number. Moreover, the 6.3% growth was far slower than investors had anticipated. 

Why is China’s economy decelerating? There are several possible explanations. These include weak private sector investment due to uncertainty about government policy toward the private sector, declining property investment due to troubles in the property market, cautious consumer spending, and declining exports due to a weakened global economy. In part, weak demand has contributed to the near extinction of inflation in China. Meanwhile, although monetary policy has been loosened, the central bank has taken a cautious approach. Moreover, fiscal policy remains cautious owing to a high level of local government debt.

Several indicators other than GDP point to a weak Chinese economy. First, in the first six months of 2023, fixed asset investment increased only 3.8% from a year earlier. This modest level masked a wide diversion between different sectors. For example, investment in infrastructure was up 7.2% while investment in manufacturing was up 6%. Moreover, investment in high technology industries was up 12.5%. On the other hand, investment by the private sector fell 0.2% while investment in the property sector fell 7.9%. The weakness of the latter two categories played an important role in suppressing GDP growth.

Although private sector investment growth was weak, investment by the state sector was significantly better. However, this could be seen as detrimental to longer-term growth. That is, the private sector has played a disproportionate role in boosting productivity in the Chinese economy, and private sector investment has generated a higher return than state sector investment. 

Second, retail sales in China were up 3.1% in June versus a year earlier, the slowest growth since December 2022 when the economy was disrupted by a new wave of COVID-19 infections. Some categories did especially poorly. This included automobiles (down 1.1%), building materials (down 6.8%), furniture (up 1.2%), and office supplies (down 9.9%). Even those categories with stronger growth saw a deceleration from May to June. The troubles in the property market probably contributed to weak retail sales, both due to weak demand for home-related products as well as the impact of declining home prices of household wealth. 

Third, Chinese industrial production accelerated slightly in June, with output up 4.4% versus a year earlier compared to growth of 3.5% in May. The June number was the best since October 2022. This was fueled by 4.8% growth of manufacturing output. There was strong growth of output for ferrous metals (up 7.8%), nonferrous metals (up 9.1%), chemicals (up 9.9%), electrical machinery (up 15.4%), and semiconductors (up 30.9%). On the other hand, output of computers and communications equipment increased only 1.2%. 

The weakness of the economy has led to calls for further easing of monetary policy. However, the People’s Bank of China (PBOC) left several key interest rates unchanged last week. It is likely that the PBOC is wary of increasing the gap between Chinese and US interest rates, thereby putting further downward pressure on the value of the renminbi.

What does China’s weakness mean for the global economy? First, weaker growth in China means weaker exports to China from many countries. Indeed, US Treasury Secretary Yellen said that “slow growth in China can have some negative spillovers for the United States.” Second, a weak China means lesser demand for global commodities, including energy. That, in turn, suggests downward pressure on energy prices. That is good news in terms of suppressing global inflation. Finally, weaker growth in China might influence Chinese policymakers’ attitudes toward relations with the rest of the world. It could lead China to prioritize repairing fraught economic relationships with the United States and Europe. Or the weakness of the external sector could lead China to prioritize domestic demand through fiscal stimulus and/or deregulation.  

US retail sales weak, while households have plenty of cash available

  • Retail sales in the United States grew slowly in June. This is not entirely surprising. Retail spending mostly involves goods (except for restaurant meals). Spending on goods has been relatively dormant in the past two years of recovery from the pandemic. Meanwhile, spending on services has grown, offsetting the weakness in goods spending.

As for retailing, sales (not adjusted for inflation) were up 0.2% from May to June and up 1.5% from a year earlier. In part, the weakness reflected the sharp decline in the price of gasoline. As a result, spending at gasoline stations fell 1.4% from May to June and was down 22.7% from a year earlier. Excluding gasoline stations, retail sales were up 0.3% from May to June and up 4.2% from a year earlier. 

Some categories of retailers exhibited weakness. This included building materials (down 1.2% from May to June), grocery stores (down 0.7%), sporting goods stores (down 1%), and department stores (down 2.4%). Strong categories were nonstore retailers (up 1.9%), electronics stores (up 1.1%), and furniture stores (up 1.4%). 

  • During the pandemic, households in many countries accumulated excess savings (savings above the normal pattern), largely due to fiscal stimulus. This was especially and disproportionately true in the United States, but it happened elsewhere as well. Over time, much of this excess savings have been depleted as households attempted to stabilize their spending to offset declining real incomes (which fell because wages did not keep pace with inflation). 

For the United States, there are a range of estimates of the amount of excess savings available to households. The Federal Reserve Bank of San Francisco estimates that accumulated excess savings from the start of 2020 until August 2021 was roughly US$2.1 trillion. Of that, consumers have spent about US$1.6 trillion. That means that there is roughly US$500 billion remaining. The Federal Reserve Bank of St. Louis estimates that remaining excess savings were roughly US$1.0 trillion by the end of the first quarter of 2023. Meanwhile, Fitch Ratings estimates that, in May there was roughly US$900 billion in remaining excess savings. The Center for Economic Policy Research (CEPR), meanwhile, says that US households have already depleted their excess savings. Estimates vary depending on assumptions about what constitutes excess saving and when the accumulation began. 

If we assume that some excess savings remain in the United States, households will continue to dip into this pool if they need to offset declining real wages to sustain spending. However, real wages have stopped declining as of May. However, Fitch estimates that 80% of excess savings are held by the top 20% of households by income. These relatively affluent households are more prone to save. Indeed, they have used this money to acquire financial assets such as equities and, therefore, are less likely to liquidate. Thus, there is some uncertainty about the degree to which households will utilize this pool of funds. The answer to this riddle will have a big impact on how fast the US economy grows in the coming year.  

Japanese inflation remains elevated

  • Inflation in Japan continues to be historically high. In June, consumer prices were up 3.3% from a year earlier. This is down from recent months but remains well above the Bank of Japan’s (BOJ’s) 2% target. Moreover, this was the first time in eight years that Japanese inflation exceeded inflation in the United States. When that last happened in 2015, it was because Japan had enacted a significant increase in the national sales tax, thereby causing a temporary spike in inflation. 

More importantly, core-core prices, which exclude energy and fresh foods, were up 4.2% in June versus a year earlier. This is the most commonly used measure of underlying inflation. This was down from an historic peak of 4.3% in May. 

This is a new world for Japan that faced persistent deflationary pressure over the past three decades. The BOJ has indicated that the current surge in inflation is likely temporary and due to factors that will soon reverse. It believes the inflation is due to supply constraints rather than excess demand, and that supply problems are already abating. In addition, it sees the drop in energy prices as boding well for a decline in inflation. Consequently, the BOJ has not yet moved away from the easy monetary policy that was implemented at the start of the pandemic.

Still, there is increasing discussion by economists and others suggesting an increased likelihood that the BOJ will reverse course and tighten monetary policy. One reason for this expectation is that, for the first time in decades, wages in Japan have accelerated significantly. This could propel inflation. On the other hand, the BOJ is likely concerned that tightening monetary policy will boost the value of the yen, thereby hurting the competitiveness of Japanese exports. Moreover, a tighter monetary policy risks weakening an economy that is only starting to recover from the pandemic.

The geopolitics of the clean energy transition

  • The transition to clean energy is leading to a surge in the demand for key minerals including lithium, cobalt, copper, nickel, manganese, graphite, and rare earths such as gallium and germanium. Producing solar panels, wind turbines, and electric car batteries requires far more minerals than production of traditional carbon-based methods of producing energy.

The International Energy Agency (IEA) says that a typical electric car requires six times the mineral input as a conventional automobile. The IEA says that, if the world is to meet the targets of the Paris Climate Agreement, then the demand for these minerals will likely quadruple in the coming two decades. And, if the world is to reach carbon neutrality by 2050, this will require a six-fold increase in the demand for critical minerals by 2040, potentially creating new geopolitical conflicts similar to what happened with oil and gas in the past. In fact, the IEA, which was created to monitor the global market for oil and gas, is now placing more of its focus on the market for critical minerals. It says that, by 2040, demand for clean energy minerals will exceed demand for coal.

According to the IEA, a transition to electric vehicles will entail a dramatic increase in the demand for lithium, followed by graphite, cobalt, and nickel. Expanding electricity networks to meet the demands of electric vehicles will boost demand for copper. IEA also says that transitioning the electric grid to noncarbon fuels will involve a big increase in demand for other minerals, but it will depend on the type of energy production. For example, nuclear, biomass, and hydro power would use far fewer minerals than production of wind or solar power.

Also, the growth of demand for key minerals will depend on government climate policies, relative prices of various commodities (which could be influenced by government trade policies), and the evolution of technology (including battery chemistry). In fact, the decline in the cost of producing electric car batteries played a role in boosting demand for lithium and other minerals in recent years.

Regarding geopolitics, the problem is that there is already a substantial geographic concentration in the mining of key minerals, and an even greater concentration in the processing of those minerals. For example, the Democratic Republic of Congo (DRC) and China account for 70% and 60% of the production of cobalt and rare earths, respectively. China accounts for up to 70% of lithium and cobalt refining and 90% of rare earth refining. And Chinese companies have invested heavily in mines in Australia, DRC, Indonesia, and Chile. Western governments worry that this concentration gives China the kind of leverage that Persian Gulf nations possessed in the 1970s with respect to oil. Indeed, China has already announced restrictions on rare earth exports. That is a concern for Western governments that want to boost domestic production of electric vehicles.

Part of the problem is that, for private sector mining companies, there are huge risks associated with making new large-scale investments, especially price volatility and interest-rate volatility. For Chinese state-owned companies that can tap into government subsidies, this is less of a concern. Thus, there is increasing discussion among Western governments about offering subsidies or guarantees to private investors in order to boost such investment. Indeed, the US government’s Inflation Reduction Act was meant to address these issues among others.

Notably, investment in minerals has been strong, leading the IEA’s executive director to state that “we are less worried than we were two years ago in terms of availability of critical minerals.” However, in 2022, Chinese companies doubled their mineral investments while major private sector companies increased their investments by roughly 25%.

How generative AI could disrupt labor markets

  • How much will generative artificial intelligence (AI) disrupt global labor markets? This is a key question. AI has the potential to cause machines to replace large numbers of people. It can also augment the productivity of existing workers. And it can lead to the creation of new industries that employ large numbers of people. AI could shift the mix of skills that businesses demand. If the skills composition of the labor force does not change commensurately, there could be a rise in income inequality and a failure to fully take advantage of all that AI has to offer.

In any event, the Organization for Economic Cooperation and Development (OECD) has offered a new analysis of the issue, focusing on the potential for labor displacement. Specifically, the OECD has examined the impact on the manufacturing and financial services industries, both of which have been leaders in integrating AI into their processes. The OECD surveyed both employers and employees in these industries to learn about the potential for disruption. It found that “occupations at highest risk of automation account for about 27% of employment.”

On the other hand, the OECD found that AI not only displaces jobs, but changes many jobs as well. It said that 63% of workers surveyed said that AI “is having a positive impact on job quality” (although 60% fear that AI will replace them). The AI revolution has increased the importance not only of AI skills but also of human skills “even more.” On balance, the OECD says that AI has been more important in changing rather than displacing work.

However, it should be noted that these are early days. AI implementation has been modest so far. More intensive implementation could be more disruptive going forward. The OECD says that the share of companies in OECD countries that have begun to implement AI is still in single digits. However, one in three large firms have started the process. The greatest barrier to implementation is cost. The second greatest barrier is “a lack of skills to adopt AI.” On the other hand, the cost of AI is rapidly falling. Moreover, the availability of workers with relevant skills is increasing.

Interestingly, the OECD says that high-skill jobs are more vulnerable to being replaced by AI than lower-skill jobs. This implies that disruption might reduce income inequality by reducing wage pressure for high-skill positions. On the other hand, in the longer run, AI could lead to the creation of new industries/companies that will entail an increased demand for higher-skill workers. On balance, the biggest risk is that the labor force may not be prepared for the opportunities presented by AI, thereby suppressing the productivity gains that come from AI.

US inflation falls sharply. How shall we interpret this?

  • When US inflation started to rapidly accelerate in early 2021, some people (including Fed Chair Powell) said that high inflation would be transitory. That is, it was driven by temporary factors that would eventually go away. I agreed with that assessment at the time. Then, when the war in Ukraine exacerbated energy and food price inflation in 2022, some people began to wonder if inflation would indeed be transitory or if we were in a new era of permanently higher inflation. Instead, inflation has decelerated quite rapidly from a year ago. Perhaps it was transitory after all.

Recently, the US government reported that consumer prices were up just 3% in June versus a year earlier. Recall that inflation peaked one year ago at 9.1%. Today’s number was the lowest since March 2021. Moreover, consumer prices were up only 0.2% from the previous month.

In part, the favorable report reflected the continuing impact of declining energy prices. Indeed, energy prices were down 16.7% from a year earlier, although they were up 0.6% from the previous month. What economists focus on, however, is underlying inflation. When volatile food and energy prices are excluded, core prices were up 4.8% from a year earlier, also a substantial deceleration. This was the lowest core inflation since October 2021. Core inflation had peaked last September at 6.6%. Also, core prices were up 0.2% from the previous month—a very low number.

The trend has clearly been favorable while the deceleration of inflation has been bigger than recently expected. Will it continue, or will inflation get stuck at a slightly elevated level? These are questions that the policymakers at the Federal Reserve will have to consider as they deliberate on their next move. They have signaled a strong likelihood that they will boost the benchmark rate two more times this year. The most recent report could lead them to cut that to one move, or perhaps no move. An examination of the details will help to discern underlying trends.

First, some categories that saw big price increases as the pandemic faded are now in decline. This includes airline fares (down 18.9% from a year earlier), used cars (down 5.2%), and information technology commodities (down 7.7%). The latter included a 5.2% decline for computers and a 16.1% decline for smartphones. Meanwhile, the categories contributing the most to inflation were food (up 5.7%) and shelter (up 7.8%). The latter reflects the lagged impact of rising home prices. Yet, now that home prices are declining, this will gradually feed into the shelter component of the consumer price index, helping to bring inflation further down in the months to come. In fact, if shelter is excluded, then consumer prices were up a mere 0.7% in June versus a year earlier. If food and shelter are excluded, prices were down 0.6%. And, if food, shelter, and energy are excluded, prices were up a modest 2.7%.

By broad category, prices of durable goods were down 0.8%, prices of nondurables were down 1.3%, while prices of services were up 5.7%. Yet services excluding shelter were up a more modest 3.2%.

What accounts for the sharp deceleration of inflation? There are several factors. These include a sharp consumer spending swing away from goods (explaining the decline in goods prices), a major improvement in supply chain efficiency, a decline in energy prices, and an overall weakening of the economy due to tightening of monetary policy. One of the fears of the Fed is that the tight labor market could drive significant wage gains, thereby making it difficult to suppress inflation. So far, this has not been the case. Wage inflation has lately decelerated while the job market appears to be loosening as evidenced by slower job growth and a declining vacancy rate.

  • In the aftermath of the latest and surprisingly good inflation report for the United States, many investors are debating what it means for Fed policy and for the economic outlook. While inflation in June was lower than many had anticipated, the report did not change investor expectations about the future path of inflation. The five-year and 10-year breakeven rates have remained relatively steady since March. Breakeven rates are measures of bond investor expectations of future inflation. Breakeven rates are calculated by subtracting the yield on inflation-protected bonds from the yield on regular bonds. Currently, the 10-year breakeven rate is 2.26% while the five-year rate is 2.18%—both indicating that investors expect inflation to quickly revert to a level consistent with the goals of the Federal Reserve.

Notably, the 10-year exceeds the five-year, which is normal. However, since the start of the inflationary episode, the five-year exceeded the 10-year, indicating that bond investors expected a short-term surge in inflation followed by a quick decline. Since May, however, the five-year has exceeded the 10-year, indicating that bond investors no longer expect any surge in inflation. They are evidently confident that inflation will continue to decelerate.

Also, it is interesting to see how currency markets have functioned lately. After a long period in which the value of the US dollar rose against other major currencies (due to faster monetary tightening in the United States than elsewhere), the dollar has been falling lately, hitting a 15-month low after the latest inflation report. This reflects confidence that monetary tightening in the United States is almost over, while tightening continues in Europe and may soon begin in Japan. What does this imply? It means higher overseas profits for US companies, less pressure on emerging market debtors, and increased local currency revenue for commodity exporting nations.

One of the goals of the Federal Reserve is to anchor expectations of inflation, thereby averting a wage-price spiral stemming from a tight labor market. It appears that the Fed has achieved its goal. Moreover, with inflation now running lower than anticipated, and with the labor market starting to show signs of weakening, it seems likely that the Fed will soon pause monetary tightening. In June, when the Fed halted rate increases, it signaled a likelihood of two more rate hikes this year. Now, following the latest inflation report, many analysts predict just one more hike followed by a long pause.

China skirts deflation

  • For the past two years, the biggest economic issue in Europe and North America has been ruinous inflation, leading central banks to substantially tighten monetary policy. Yet in China, this has not been the case. In fact, not only has inflation been low. It has disappeared. That is, consumer prices are declining, leading to fears of a general deflation. China’s central bank has, consequently, been loosening monetary policy. This reflects significant weakness in the Chinese economy, the opposite of Europe and North America where overheated economies led to a need to tighten monetary policy.

Here are the details: In June, Chinese consumer prices were unchanged from a year earlier, the first time they failed to rise on an annual basis since early 2021. When volatile food and energy prices are excluded, core prices were up only 0.4% from a year earlier. Moreover, consumer prices fell 0.2% from May to June. This was the fifth consecutive month in which consumer prices fell from the previous month.

Also, producer prices in China (often known as factory gate prices) are falling sharply. In June, producer prices were down 5.4% from a year earlier, the ninth consecutive month of decline and the biggest drop since December 2015. This suggests excess capacity, a sign of economic weakness. It also reflects the decline in global commodity prices. Moreover, producer prices feed into consumer prices. Thus, the drop in producer prices augurs a possible further decline in consumer prices in the coming months.

There are two things we can infer from these reports. First, they signal considerable weakness in demand in the Chinese economy. This has already been evident in various reports about the performance of industrial production, retail sales, fixed asset investment, exports, and property sector activity. Price weakness suggests continued weakness in economic performance in the months ahead, absent new initiatives by the government to boost growth.

Second, these reports increase the likelihood of further easing of monetary policy by the People’s Bank of China, which is focused on reviving the economy when faced with a confluence of headwinds. These include weak external demand, fraught relations with the United States, dormant private sector investment, a troubled property market, cautious consumer behavior, and worsening demographics.

The problem with more monetary easing is that it might not work. That is, if households and businesses are intent on hoarding cash, a cut in interest rates will not likely boost credit activity significantly. That is where fiscal policy comes in. The government could borrow more to spend on things like infrastructure. In fact, the Chinese Academy of Social Sciences, a government-funded think tank, has urged a new fiscal stimulus. The problem with this is that the country already has an unusually high volume of debt. Moreover, there could be diminishing returns from infrastructure investment. Thus, it might be difficult for policymakers to boost the pace of growth absent major structural reforms.

Perhaps most worrisome to policymakers has been the sharp rise in youth unemployment. China’s unemployment rate among those 16 to 24 years old, at 20.8% in May, is now higher than in any G7 country. Moreover, this is up from 10% as recently as 2019. This comes at the same time that there has been a surge in the number of university graduates, up almost 50% in the past five years. This mismatch between the supply and demand for young workers can only be resolved if the economy grows faster. In the interim, it likely means that many young graduates will take jobs below their skill level.

US job market decelerates but remains strong

  • In June, the US job market slowed considerably, although employment growth was relatively good by historical standards. The unemployment rate fell slightly while wage growth continued at a modest pace. Here are the details:

The US government publishes two reports on the employment situation: one based on a survey of establishments; the other based on a survey of households. The establishment survey found that 209,000 new jobs were created in June. While down from the rapid growth seen in May, this was comparable to job growth in March and April. Employment was up 2.5% from a year earlier. While down sharply from the last two years of postpandemic recovery, this remains a far higher rate of growth than was normally seen in the prepandemic years.

Naturally, the devil is in the details. The biggest sources of job growth in June were in health care (up 65,200) and government (up 60,000). Excluding these categories, job growth was a relatively feeble 84,000. Some categories saw a decline in employment, including mining (down 1,000), retail trade (down 11,200), wholesale trade (down 3,600), and transportation and warehousing (down 6,900). Modest growth was seen in other categories, even those that previously generated strong growth, such as leisure and hospitality as well as professional services. The biggest percentage gains in employment were in construction.

Meanwhile, the government also reported that average hourly wages were up 4.4% from a year earlier, the same rate of growth as in the previous two months. Thus, it appears that wage inflation is stabilizing at a rate slightly above the most recent rate of inflation. If this continues, it will make it more difficult for the Federal Reserve to further suppress inflation, especially if productivity growth remains slow. Thus, from the Fed’s perspective, there could be a need to weaken the labor market, thereby reducing wage pressure. Last week’s report of modest job growth could be a sign that the Fed is succeeding in weakening the job market. Or it could be a sign that there is not much room for further job growth absent a big increase in labor-force participation—which did not happen this month.

In addition, the government published its survey of households that includes the more than nine million people who are self-employed. This found that the labor force grew in line with the growth of the working-age population, thereby keeping the participation rate steady. Employment grew faster than the labor force, causing the unemployment rate to fall to 3.6%. For the last year, the unemployment rate has fluctuated between 3.4% and 3.7%. Meanwhile, the number of people unemployed for 15 weeks or more as a share of the labor force was steady at 1.2%. This is indicative of a tight labor market.

Investors barely reacted to the latest report. Following release of the report, the yield on 10-year bonds was mostly unchanged while the yield on two-year bonds fell modestly after having risen previously. Equity prices were up modestly. The futures market implied that the probability of a Fed rate hike next month remained unchanged at about 90%. Investors evidently saw the report as signaling a modest deceleration of job market activity, but a job market that remains too tight.

Also, ADP, a payroll processing company, releases a monthly estimate of private sector job growth, which is sometimes a good predictor of the government’s official job numbers. That was not the case last week. The latest ADP report said that 497,000 new private sector jobs were created in June, an unusually high number. Thus, APD’s estimate was not consistent with the actual trend in the job market. However, it did provide some interesting insights. For example, ADP reported a decline in employment in companies with more than 500 employees. I’ve had numerous clients ask how it can be that the job market is strong when so many large companies have announced layoffs. The answer, evidently, is that large companies are not hiring. In fact, almost all the job growth reported by ADP took place in companies with fewer than 250 employees.

The fact that all private sector job growth took place among small and medium-sized businesses does not bode well for productivity growth. That is because it is large companies that are making significant investments in new technologies such as artificial intelligence (AI). They will likely experience productivity gains early while smaller companies, which will likely lag in such investments, will experience them later. For the economy overall, so long as smaller companies account for the lion’s share of job growth, then productivity gains will take time to materialize.

Meanwhile, the US government released its Job Openings and Labor Turnover Survey (JOLTS), which indicated that, although the number of job openings fell by 496,000 in May, the number remained historically high. Moreover, the number of people voluntarily leaving jobs (quits) increased by 250,000, indicating confidence in the ability to find other employment.

The job-openings rate (the share of available jobs that are not filled) was 5.9% in May, down from 6.2% in April and down from 7% a year earlier. By industry, the highest openings rates in May were in hotels and restaurants (7.7%), transportation/warehousing/utilities (7.6%), health care (7.5%), and professional and business services (7.3%). The lowest openings rates were in wholesale trade (3.9%), manufacturing (4.4%), and finance/insurance (4.4%).

US financial conditions improve. Fed sees need for more tightening

  • The tightening of monetary policy by the Federal Reserve over the last year and a half was meant to worsen financial market conditions and thereby curtail credit market activity. The purpose was to weaken the economy enough to reduce inflationary pressure. There are various measures of financial market conditions that both policymakers and investors follow. Most are relatively backward looking. However, the Federal Reserve has now proposed a new index of financial conditions that is meant to be more forward looking than previous indices.

In explaining the new index, the Fed reported that “while existing financial conditions indices (FCIs) typically measure whether financial conditions are tight or loose relative to their historical distributions, the new index assesses the extent to which financial conditions pose headwinds or tailwinds to economic activity.” In other words, the Fed is attempting to assess whether financial conditions are slowing or speeding up economic growth.

The good news is that the index has been declining for the past several months, despite continued tightening of monetary policy. In part, this might reflect the impact of the Fed’s considerable intervention in credit markets following the collapse of Silicon Valley Bank. In addition, it might simply reflect the surprising resilience of the US financial system. The bad news is that the index remains well above the levels seen in the decade since the global financial crisis of 2008–09. However, the index reached a much higher peak during that crisis than during the recent disruption. The bottom line is that financial conditions are relatively good, which is not necessarily what the Fed wants to see. Given that underlying inflation remains high and persistent, the Fed would rather see further weakening of financial conditions.

In fact, that is what the minutes of the Fed’s last policy meeting reveal. The minutes state that “participants generally noted that banking stresses had receded and conditions in the banking sector were much improved since early March.” In addition, “participants noted that labor market conditions remained very tight, with robust payroll gains and the unemployment rate still near historically low levels.” Thus, “participants agreed that inflation was unacceptably high and noted that the data, including the CPI for May, indicated that declines in inflation had been slower than they had expected.”

Given this, participants debated as to whether the tightening of monetary policy that has already taken place is sufficient to further reduce inflation. Thus, participants “noted that the full effects of monetary tightening had likely yet to be observed, though several highlighted the possibility that much of the effect of past monetary policy tightening may have already been realized.” Consequently, “almost all participants judged it appropriate or acceptable to maintain the target range for the federal funds rate at 5% to 5.25% at this meeting.” However, the committee hinted at the possibility of further rate hikes and voted to continue reducing the Fed’s balance sheet through the sale of assets. Thus, monetary policy is currently at a point of uncertainty.

Japanese wages accelerate while spending remains weak

  • In Japan, wages are rising at the fastest pace in a generation while household spending is not keeping up. Evidently, Japanese households are being cautious. Here are the details:

In May, regular wages in Japan were up 1.8% from a year earlier, the biggest increase since 1995. Total cash earnings were up 2.5% from a year earlier. Wages have been rising for the past 17 months. The biggest contributors to wage gains were financial services and professional services. However, despite the improvement in wage gains, wages failed to keep pace with inflation of 3.2%. Thus, in real terms, Japanese households are losing purchasing power. The government has been keen to boost wages to fuel increased domestic demand, especially at a time when Japan faces external headwinds. Notably, Japan’s largest labor organization said that large companies have agreed to wage increases of 3.6% this year. But wages are evidently rising more slowly in smaller companies.

Meanwhile, households spending is not improving. In fact, real (inflation-adjusted) household spending in May was down 4% from a year earlier. Real spending has declined in six of the last seven months. Real spending was down 1.1% from the previous month. By category, real spending fell 2.7% for food, 4.2% for housing, 8.9% for furniture, 4.8% for clothing, and 11.4% for transportation and communications. Spending was up 9.9% for education and up 3.7% for culture and recreation.

Service sector saves the global economy

  • With the global manufacturing industry in a funk, the only thing keeping the global economy growing is the vast services sector. This encompasses such industries as finance, wholesale and retail trade, transportation, utilities, telecoms, finance, leisure and hospitality, health care, and education. The state of services provides a window into the likely path of the economy. The latest services purchasing managers’ indices (PMIs) were released by IHS Markit. They provide a forward-looking indication of activity in services. PMIs are based on subindices such as output, new orders, export orders, employment, pricing, pipelines, and sentiment. A reading above 50 indicates growing activity. The higher the number, the faster the growth.

The latest PMIs indicate that the services sector continued to grow at a healthy pace in June. However, the pace of growth declined from May, both globally as well as in each of the major regions of the global economy. The global services PMI fell from 55.5 in May to 54.0 in June, signaling continued strong growth at a slower pace. The deceleration was driven by weaker new orders, weaker export orders, and weaker output prices. On the other hand, input prices accelerated, sentiment improved, and the volume of outstanding business increased. Thus, the sector continues to exhibit strength.

By country/region, the strongest services sector was found in India, where the PMI in June was 58.5, down from 61.2 in May. This indicates very rapid growth and is consistent with other indicators pointing to a strong Indian economy. Markit commented that “demand for Indian services continued to surge higher in June, with all four monitored subsectors registering quicker increases in new business inflows. This bullish pick-up in growth momentum supported a further sharp upturn in business activity and encouraged another uplift in employment figures, boding well for near-term growth prospects.” However, the strength of the Indian economy, combined with persistent high inflation, means that it is unlikely that interest rates will be reduced anytime soon.

In addition, the PMIs for the United States and Japan were also very strong. In the United States, the services PMI was 54.4 in June, down from 54.9 in May. Despite the modest deceleration in activity, there was a “steep rise” in new orders as well as a steep deceleration in output prices. Markit noted that “demand for services has remained surprisingly buoyant in the face of headwinds from the increased cost of living and higher interest rates, with spending still being supported by a postpandemic tailwind for spending by consumers in particular.” Consumer demand has been assisted by the ability of households to dip into the large pool of savings accumulated during the pandemic. Markit suggested that the combined effect of strong services and weak manufacturing points to GDP growth of 2%.

Meanwhile, Japan’s services PMI fell from 55.9 in May to 54.0 in June, an indication of strong growth in activity. Markit noted that output and new orders were very strong. In addition, the volume of outstanding work is very high. The strength of services has more than offset the weakness of manufacturing, thereby contributing to robust GDP growth.

In Europe, the services PMI was more modest in June, hitting 52.0, which was down from 55.1 in May. The June number was a five-month low and indicated only modest growth of activity. Markit commented that “all major euro countries have again lost considerable momentum. The slowdown in business activity growth was accompanied by a weaker rise in new business, lower price increases and a decline in business expectations.” The Eurozone country with the poorest services performance was France, with not only the lowest PMI among the big four countries in the region, but an actual decline in activity. Markit suggested that France’s pension reform protests played a role in the slowdown.

Finally, China’s services PMI fell from 57.1 in May to 53.9 in June, a sharp decline indicating a major deceleration in activity, although growth remained “solid.” Although a boost to inbound and domestic tourism following the reopening of the economy helped, the service sector was hurt by relatively weak consumer demand.


Ira Kalish

United States


Cover image by: Sofia Sergi